The Political Economy of Protectionism

Dr. DiLorenzo is the Scott L. Probasco, Jr., Professor of Free Enterprise and Director of the Center for Economic Education at the University of Tennessee at Chattanooga.

Disagreements among economists are legendary, but they are largely of one mind on the issue of free trade. Evidence of this is a recent survey of the current and past presidents of the American Economic Association—the voice of mainstream economics. The survey found these prominent economists all strongly in favor of free trade, and concluded that “an economist who argues for restricting trade is almost as common today as a physician who favors leeching patients.”[1]

Mainstream economic thinking on free trade knows no ideological boundaries. Conservative economists Milton and Rose Friedman, for example, write that “ever since Adam Smith there has been virtual unanimity among economists . . . that international free trade is in the best interest of the trading countries and the world.”[2] Liberal economist Paul Samuelson concurs: “Free trade promotes a mutually profitable regional division of labor, greatly enhances the potential real national product of all nations, and makes possible higher standards of living all over the globe.”[3]

The case for free trade is not based on any stylized economic theories of “perfect competition,” “general equilibrium,” or “partial equilibrium.” After all, Adam Smith is history’s most forceful and articulate defender of free trade, and he never heard of any of those theories. Rather, the case for free trade is based on the virtues of voluntary exchange, the division of labor, and individual freedom.

As long as trade is voluntary, both trading partners unequivocally benefit; otherwise they wouldn’t trade. The purchase of a shirt, for instance, demonstrates that the purchaser values the shirt more than the money spent on it. The seller, on the other hand, values the money more than the shirt. Thus, both are better off because of the sale. Moreover, it doesn’t matter whether the shirt salesman is from the United States or Hong Kong (or anywhere else). Voluntary exchange is always mutually beneficial.

Free trade expands consumer choice and gives businesses incentives to improve product quality and to cut costs. By increasing the supply of goods, international competition helps hold down prices and restrains internal monopolies. The “Big Three” auto makers, for instance, may wish to monopolize the automobile market, but they are unable to because of foreign competition. About 75 per cent of all domestic manufacturing industries now face some international competition, which helps keep their competitive feet to the fire. Thus, the case for free trade is the case for competition, higher quality goods, economic growth, and lower prices. By contrast, the case for protectionism is the case for monopoly, lower quality goods, economic stagnation, and higher prices. The costs of protectionism to consumers are enormous. According to very conservative estimates, protectionism costs American consumers over $60 billion per year—more than $1,000 annually for a family of four.[4] Thanks to protectionism, for example, it costs about $2,500 more to buy a Japanese-made car than it otherwise would.

Free trade increases the wealth (and employment opportunities) of all nations by allowing them to capitalize on their comparative advantages in production. For example, the U.S. has a comparative advantage in the production of food because of its vast, fertile land and superior agricultural technology and labor. Saudi Arabia, on the other hand, does not have land that is well suited to agriculture. Although Saudi Arabia conceivably could undertake massive irrigation to become self-sufficient in food production, it is more economical for the Saudis to sell what they do have a comparative advantage in—oil—and then purchase much of their food from the U.S. and elsewhere. Similarly, the U.S. could become self-sufficient in petroleum by squeezing more oil out of shale rock and tar sands. But that would be much more costly than if the U.S. continued to purchase some of its oil from Saudi Arabia and elsewhere. Trade between the U.S. and Saudi Arabia, or any other two countries, improves the standard of living in each.

Ethical Aspects of Free Trade

Protectionism is not only economically inefficient, it is also inherently unjust. It is the equivalent of a regressive tax, placing the heaviest burden on those who can least afford it. For example, because of import restraints in the footwear industry, shoes are more expensive. This imposes a proportionately larger burden on the family that has an income of only $15,000 per year than on the family that has an income of, say, $75,000 per year. Moreover, the beneficiaries of protectionism are often more affluent than those who bear the costs. Wages in the heavily protected auto industry are about 80 per cent higher than the average wage in U.S. manufacturing. The Chairman of the Chrysler Corporation was paid $28 million in 1987, thanks partly to protectionism. And, perversely, by driving up the price of automobiles, protectionism has benefited the owners, managers, and workers of the Japanese automobile industry at the expense of American consumers. Protectionism, in other words, is welfare for the well-to-do.

Protectionism also conflicts with the humanitarian goals of foreign development aid. The U.S. government spends billions of dollars annually in foreign aid to developing countries. Many of these programs are themselves counterproductive because they simply subsidize governmental bureaucracies in the recipient countries. But what good does it do to try to assist these countries if we block them from the biggest market in the world for their goods? Protectionism stifles economic growth in the developing countries, leaving them even more dependent upon U.S. government handouts.

Why Protectionism?

Despite the powerful case for free trade, both the United States and the rest of the world are highly protectionist, and always have been. This is because free trade benefits the general public, whereas protectionism benefits a relatively small group of special interests. The general public is neither well organized nor well informed politically, but the special interests are. This political imbalance was recognized by Adam Smith over 200 years ago when he wrote in The Wealth of Nations that

To expect, indeed, that the freedom of trade should ever be entirely restored in Great Britain, is as absurd as to expect that an Oceana or Utopia should ever be established in it. Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it . . . . The member of parliament who supports every proposal for strengthening this monopoly, is sure to acquire not only the reputation of understanding trade, but great popularity and influence with an order of men whose numbers and wealth render them of great importance. If he opposes them, on the contrary, and still more if he has authority enough to be able to thwart them, neither the most acknowledged probity, nor the highest rank, nor the greatest public services can protect him from the most infamous abuse and detraction, from personal insults, nor sometimes from real danger, arising from the insolent outrage of furious and disappointed monopolists.[5]

The political pressures to grant monopolistic privileges are so strong that even political figures who spend their careers speaking in favor of free trade quickly cave in to protectionist pressures once in office. U.S. Treasury Secretary James Baker recently boasted, for example, that “President Reagan has granted more import relief to U.S. industry than any of his predecessors in more than half a century.”[6] Unfortunately, the Democratic party is not very different. “There is no strong supporter of a free and open trading system,” complained Hobart Rowan of the Washington Post, “among the seven declared Democratic [Presidential] candidates.”[7]

Voters might be expected to oppose policies that stifle economic growth and redistribute income from poor to rich. But public opposition to protectionism is not very strong, explains economist Mancur Olson, because “the typical citizen is usually ‘rationally ignorant’ about public affairs.”[8] That is, the typical citizen spends most of his or her time worrying about personal matters and not economic policy. To add to the confusion, much of the information that citizens do receive about public policy is self-serving and biased information disseminated by special-interest lobbyists. As economist Gordon Tullock has written:

Special interest groups normally have an interest in diminishing the information of the average voter. If they can sell him some false tale which supports their particular effort to rob the treasury, it pays. They have resources and normally make efforts to produce this kind of misinformation. But that would not work if the voter had a strong motive to learn the truth.[9]

For decades monopolists and potential monopolists have crafted hundreds of myths about free trade and protectionism. The following are just a few examples of misinformation about protectionism.

The international trade deficit has been of concern to Congress in recent years, and has been a primary “justification” for protection. But the notion that importing more than we export is necessarily bad ignores some elementary economic principles. First, imports are our gain from trade. The more material goods—the more trade—the better. Remember, all trade is mutually beneficial.

How trade-deficit statistics can give misleading impressions of economic health is illustrated by the analogy between domestic and international trade. Most citizens probably run a trade deficit with their grocers. But who would argue that a balance of trade between consumers and grocers is necessarily desirable? A government- mandated trade balance—whether for domestic or international trade—would make both trading partners worse off. Furthermore, the notion that, say, Taiwan, with a population of 20 million, should buy as many goods from the U.S. as 230 million American consumers purchase from Taiwan is absurd. The balance of trade argument is just another weak excuse for monopolistic trade restrictions.

Myth #2:Being a “debtor nation” is economically harmful.

Being a debtor nation means that foreigners invest more in the U.S. than U.S. citizens invest abroad. Debtor nation status is not necessarily a cause for alarm, however, since foreign investment in the U.S. can be beneficial. For example, there are many obvious benefits from

Tennessee’s new Nissan plant and the 50 other Japanese companies located in that state. These new companies provide jobs, make American industry more competitive, and stimulate economic growth. The U.S. has been a debtor nation throughout most of its history, including the period from 1787 to 1920, when the nation experienced the most rapid economic growth in world history up to that time.

Alarm over becoming a debtor nation is illogical and contradictory. On the one hand, protectionists complain that too much money is leaving the country (we’re importing more than we’re exporting). Then, when the same money returns to the U.S. in the form of foreign investment, they complain that too much money is coming into the country. The protectionists cannot have it both ways. They are grasping at straws to justify monopolistic privileges.

Myth #3:Imports are destroying American jobs.

Like all long-lasting myths, this one has a grain of truth. If more American consumers buy Japanese rather than American-made cars, it may threaten some American jobs. Efforts should be (and are) made to ease the transition of those who become temporarily unemployed, but protectionism would only cause even more unemployment.

Free trade creates jobs by reducing prices, leaving more money in the pockets of consumers. Increased consumer spending in turn will stimulate production and employment throughout the economy. By contrast, higher prices in a protected industry will cause consumers to cut back on their purchases, which will result in less employment in that industry.

Also, the dollars that Americans pay for foreign-made goods eventually are respent in the U.S., which creates even more jobs. Foreigners have no use for dollars per se. They must either spend them in the U.S. or sell them to someone who will.

Protectionism may temporarily “save” jobs in one industry, but it usually destroys even more jobs elsewhere. For example, because of protectionism in the steel industry, American automakers are estimated to pay as much as $500 more per car for steel than Japanese auto-makers. Higher prices for American-made cars will cost domestic automakers business and cause them to lay off workers. Thus, protectionism in the steel industry creates unemployment in steel-using industries.

It is particularly telling that in recent years, as the trade deficit has grown, so has employment in the U.S. economy. More than 13 million new jobs were created between 1982 and 1988 as the unemployment rate dropped from nearly 11 per cent to less than 6 per cent of the labor force. In contrast, we had a trade surplus throughout the 1970s when unemployment rose steadily.

Myth #4:Because of international competition, the U.S. manufacturing sector is declining.

Protectionists have claimed that the U.S. economy is “deindustrializing” because of the alleged failure of American manufacturers to compete on international markets. But the deindustrialization theory is a hoax. Manufacturing output as a percentage of GNP is about 24 per cent today, compared to 25 per cent in 1950.[10] Moreover, manufacturing output and employment are at their highest levels ever. The composition of employment and output has changed, as it always does in a dynamic, growing economy. Economic growth always creates many dislocations. Overall, however, the U.S. manufacturing sector is not “deindus-trializing.”

Myth #5:Because of international competition, many newly-created jobs are low-paying, “dead-end” jobs.

A Congressman recently claimed that “50 per cent of the 13 million new jobs [created between 1982 and 1987] are dead-end—paying $7,400 a year or less. We’re trading good manufacturing jobs for low-pay service jobs.”[11] The Congressman asserted that international trade is “impoverishing America,” and has introduced protectionist legislation to thwart this perceived trend.

The U.S. Department of Labor recently examined these claims in great detail and found the reality to be much different from the Congressman’s rhetoric. Of the 13 million new jobs created between 1982 and 1987, 59 per cent were in the highest-wage category as classified by the Labor Department. Only 7 per cent of the new jobs were minimum-wage jobs paying $7,400 per year or less.[12]

Myth #6:Cheap foreign labor is an unfair advantage.

It is often said that if, say, textile workers in Singapore are paid only $1 per hour, American industry cannot possibly compete, given that American textile workers are paid more than $10 per hour. Protection is supposedly needed if the domestic textile industry is to survive.

This argument may appear compelling at first, but it ignores several important facts. First, if the productivity of American workers is ten times as high as in Singapore (because of superior capital, technology, and training), then higher American wages are not a disadvantage.

Second, the idea that low wages “explain” international trade patterns is illogical. If it were true, the U.S. would export almost nothing, since U.S. wages are higher than almost everywhere else in the world across the board. What determines a nation’s comparative advantage in international trade is the total amount of resources it must use to produce a given product, not just the labor. Many low-wage countries import U.S. goods because we have a comparative advantage in producing those goods despite our higher wages. Moreover, low-wage countries must eventually import goods from the U.S. because there is nothing else they can do with the dollars they receive from their American sales.

Finally, it isn’t clear why it is “unfair” for American consumers to enjoy lower-priced and/or higher-quality goods produced overseas by low-wage (or other) countries.

Myth #7:Protection is necessary to counteract “dumping.”

So-called dumping occurs when foreign manufacturers sell products in the U.S. that supposedly are priced below the price at which they are sold in the home market. There are numerous laws that prohibit dumping on the grounds that it is unfair competition.

But there are also sound economic reasons for such business practices. Temporarily charging prices that are below cost is a common competitive business practice. For example, newly-established pizza parlors typically offer “two for the price of one” specials as an inducement to consumers to try out their product. The losses incurred during the sales are considered an investment that will yield future sales by generating a clientele. Lower prices always benefit consumers, but we seldom charge the local pizza parlor with “dumping.” Perhaps this is because consumers can plainly see the benefits of such competition.

In November 1987, the U.S. Commerce Department ruled that “Japanese companies violated international trade laws by failing to increase their prices to match the sharp rise in the value of the yen.”[13] With the rise in the value of the yen, Japanese goods sold in the U.S. became relatively more expensive. The Japanese producers responded by cutting their costs, prices, and profit margins to remain competitive, to the great satisfaction of American consumers. According to the Commerce Department, Japanese export prices declined by 23 per cent between 1985 and 1987. Unfortunately, the protectionist Reagan administration is opposed to such price cutting.

Dumping is often said to occur because foreign governments subsidize some of their manufacturers, which allows the companies to underprice American firms. These policies may be misguided, but there is no reason why American consumers should be punished for the short-sighted policies of foreign governments. Such subsidies constitute a “gift” from foreign taxpayers to American consumers and may be thought of as foreign aid in reverse. Moreover, the extent to which this subsidization takes place has been greatly exaggerated. In Japan, for instance, the amount of assistance given to Japanese manufacturers by the Japan Development Bank has amounted to less than one per cent of gross domestic investment, and most of that has gone into the agricultural sector.

Dumping is also objected to on the grounds that it is a means of monopolizing American industries by driving out the competition with low prices. There have been no documented examples of such monopolization, however, and for good reason. Any manufacturer who charged monopolistic prices would face fierce international (and domestic) competition that would quickly dissipate any monopoly power. Businesses that charge their international competitors with dumping are simply unwilling to charge prices that are as low as their rivals’.

Myth #8:Temporary protection is needed to “buy time” and adjust to the competition.

Temporary trade relief is like being a little bit pregnant. The textile industry, for example, was given “temporary” trade relief 25 years ago and is still being “relieved.” This rationale admits that protectionism is a bad idea, which is why it is labeled as only temporary. However, it is bound to make things worse for the industry, not better.

By reducing competitive pressures, protectionism tends to stifle innovation. Businesses are less prone to invest in engineering and technology when profits can be earned just as easily by lobbying for protection.

There is much evidence, moreover, that “temporary” protection does not revitalize industries, and probably is even counterproductive. The federal government’s Congressional Budget Office studied protectionism in the textile, steel, footwear, and automobile industries, and concluded that “in none of the cases studied did protection . . . revitalize the affected industry . . . . Protection has not substantially improved the ability of domestic firms to compete with foreign producers.”[14] The study showed that investment often declines during periods of protection, which causes the protected industries to fall even farther behind the competition. Such evidence explains why a closely related protectionist argument-the military might argument—is also fiction. Specifically, if an industry is important to national defense, it supposedly should be protected from international competition. But since protection saps incentives for innovation, resulting in lower-quality and higher-priced goods, it will weaken the national defense by weakening industries that the military relies upon.

Myth #9:We should restore a “level playing field” by erecting trade barriers against countries that have trade barriers against us.

This is a “cutting off our nose to spite our face” strategy. If foreign governments are foolish enough to harm their own Citizens by erecting trade barriers, it is unfortunate for those citizens. But there are no sound reasons why American consumers should be penalized for the ill-conceived trade policies of foreign governments.

Furthermore, trade retaliation would be hypocritical, since American trade restrictions on foreign imports are often much greater than foreign restrictions on American imports. The American auto parts supply industry, for example, is currently lobbying for protection on the grounds of “unfair competition” from Japanese auto parts suppliers. The hypocrisy of this claim stems from the fact that there are no Japanese government-imposed barriers to importing American auto parts into Japan, but Japanese parts producers must pay American tariffs when exporting to the U.S.

Trade retaliation can be a very dangerous political game. The Smoot-Hawley tariff of 1930 spawned an international trade war that helped precipitate the Great Depression. Dozens of countries responded to the Smoot-Hawley tariff by erecting trade barriers for American-made goods. Consequently, the value of imports in the 75 most active trading countries fell from over $3 billion in 1929 to about $1 billion by 1932, driving the world economy into a depression.[15]

Trade retaliation is inherently counterproductive. By reducing the flow of dollars from the U.S., foreigners will have fewer dollars to spend in the U.S., which eventually will harm American export industries. American exports generally fall once imports are reduced. Consequently, employment in export-related industries, which account for as much as one-fifth of all employment in the U.S., will fall.[16]

Myth #10:Protectionism benefits union members.

This is probably true in the short run, but certainly not in the long run. Because of protectionism in such industries as steel, automobiles, textiles, and footwear, unions once prospered by imposing featherbedding rules and by bargaining for supra-competitive wages. As long as international competition was not very effective, raising wages while reducing productivity was feasible. However, international competition eventually seeped in, as it inevitably does, and American industries found themselves at a severe competitive disadvantage. They lost market share, laid off thousands of workers, and union membership declined dramatically. Thus, protectionism may have helped unions in the short run, but is a main cause of their current malaise. It is no coincidence that some of America’s most lethargic unionized industries—steel, automobiles, footwear, rubber, textiles—are also among the most heavily protected.

Conclusions

In sum, a dynamic economy is essential for economic growth and job creation, and protectionism only hinders the necessary adaptations to economic change. As Nobel Laureate Friedrich Hayek has written, the benefits of competition and economic growth

are the results of such changes, and will be maintained only if the changes are allowed to continue. But every change of this kind will hurt some organized interests; and the preservation of the market order will therefore depend on those interests not being able to prevent what they dislike . . . . this general interest will be satisfied only if the principle is recognized that each has to submit to changes when circumstances nobody can control determine that he is the one who is placed under such a necessity.[17]

Protectionism may provide some short-term benefits to a small number of special interests, but at much greater costs to the rest of society. Restraints on international trade are inefficient, inequitable, and counterproductive, and should not be imposed. []

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December 2014

Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.